High school graduation is just around the corner and if your graduate is heading off to college this fall, here is some important information on financial aid that you should be aware of.
What is financial aid?
Financial aid is money distributed primarily by the federal government and colleges in the form of student loans, grants, scholarships and work-study jobs. Loans and work-study must be repaid (through monetary or work obligations), while grants and scholarships do not. A student can receive both federal and college aid.
Financial aid can be further broken down into two categories: need-based, which is dependent on your child’s financial need, and merit-based, which is awarded according to your child’s academic, athletic, musical or artistic merit. Most financial aid is need-based.
How is financial need determined?
The federal government’s aid application, the FAFSA, uses a formula known as the federal methodology. A detailed analysis of the formula is beyond the scope of this discussion, but generally speaking, parent and child income and assets are tallied and assessed at certain rates. The result is a figure known as your expected family contribution, or EFC. This is the amount of money you must contribute to college costs to be eligible for aid. Your EFC remains constant, no matter which college your child applies to.
Your EFC is not the same as your child’s financial need. To calculate financial need, subtract your EFC from the cost at a given college. Because tuition, fees and room-and-board expenses are different at each college, your child’s financial need will vary depending on the cost of a particular college.
Example: You fill out the FAFSA and your EFC is calculated at $5,000. College A costs $20,000 per year and College B costs $40,000 per year. Your child’s financial need at College A is $15,000 and $35,000 at College B.
What assets are excluded from consideration?
There are certain parental assets that are excluded from calculation. Generally, they are retirement accounts such as 401(k), 403(b), IRA, SEP, SIMPLE, Pension, Keogh and Roth IRA’s. While these account balances are not included, the prior year’s contribution to any of these accounts is added back in to your gross income.
What assets are included?
Non-retirement accounts such as checking, savings, CD’s, brokerage, investment real estate, stocks, bonds, mutual funds, ETF’s and 529 Plans are all counted in parent’s assets. Note: trust funds must be reported whether or not the funds are currently available to you or the child.
When calculating the EFC, a larger percentage of assets owned by the child is used. 20 percent of all child-owned assets must be used per year to pay for college. Only 5.64 percent of parental assets are allocated to paying for college per year. In addition, there is an allowance of anywhere from $25,000-$50,000 that is excluded for consideration from parental assets. This is the reason that placing a lot of assets in your child’s name can be detrimental in receiving financial aid.Children receive no allowance.
Note: 529 Plans are always considered parental assets.
How do I apply and when?
The FAFSA can be completed manually and mailed to the regional processor listed on the form, but the better option is to complete and file it online at www.fafsa.ed.gov. The online version flags suspected mistakes immediately and takes only one week to process (compared to two to four weeks for paper FAFSAs).
The FAFSA relies on information from your previous year’s tax return, so it can’t be filed before January 1 in the year that your child will be attending college (the official federal deadline for filing the FAFSA is June 30, but many colleges have an earlier deadline). Parents should try to submit the FAFSA as close to January 1 as possible because some financial aid programs operate on a first-come, first-served basis. Even if you haven’t completed your federal income tax return, Uncle Sam lets you base your FAFSA answers on an estimated return, though you will have to provide a copy of your final income tax return later.
After your FAFSA is processed, your child will receive a Student Aid Report either in the mail or electronically (depending on how the FAFSA was filed), which highlights your EFC. Colleges that you list on the FAFSA will also get a copy of the report. In addition, you will need to submit the institutional PROFILE form to colleges that require it by the stated deadline (this form is typically submitted electronically as well). Then, the financial aid administrator at each school will try to craft an aid package to meet your child’s financial need.
Comparing aid awards
Sometime in the spring, your child will receive financial aid award letters that detail the specific amount and type of financial aid that each college is offering. To compare offers, first determine your out-of-pocket cost, or net price, for each school by subtracting any grant or scholarship aid (which doesn’t need to be repaid) from the total cost of attendance. Next, look at the loan component of each award to see how much, if any, you or your child will need to borrow. Then compare the net price and loan amounts across all colleges.
If you’d like to lobby a particular school for more aid, tread carefully. A polite letter to the financial aid administrator followed up by a telephone call is appropriate. Your chances for getting more aid are best if you can document a change in circumstances that affects your ability to pay, such as a recent job loss, unusually high medical bills or some other unforeseen event.
Common federal aid programs
Here are some names you’ll be hearing as you navigate the world of financial aid:
• Stafford Loan–The most common federal student loan for college and graduate students. Interest may be subsidized (paid by the government during school, the grace period and deferment periods) or unsubsidized. For undergraduates, the interest rate is fixed at 4.66 percent for both subsidized and unsubsidized loans disbursed July 1, 2014 through June 30, 2015 (6.21 percent for graduate students).
• Perkins Loan–A federal student loan for college and graduate students with the greatest financial need. The interest rate is fixed at 5 percent.
• PLUS Loan–A federal education loan for parents of college students and independent graduate students. A separate application is required, though filing the FAFSA first is a prerequisite. Parents can borrow the full cost of their child’s education, minus any financial aid received; the only criteria is a good credit history. The interest rate is fixed at 7.21 percent for loans disbursed July 1, 2014 through June 30, 2015.
• Pell Grant–The Pell Grant is available to undergraduates with exceptional financial need.
A word about merit aid
Colleges often use favorable merit aid packages to attract certain students to their campuses, regardless of their financial need. The availability of college-sponsored merit aid tends to fluctuate from year to year and from college to college as schools decide how much of their endowments to spend, as well as the specific academic and extracurricular programs they want to target. As a family researching college options, exploring college merit aid is probably the single biggest thing you can do to optimize your bottom line.
Besides colleges, a wide variety of groups offer merit scholarships to students meeting certain criteria. There are several websites where your child can input his or her background, abilities, and interests and receive (free of charge) a matching list of potential scholarships.
How much should you rely on financial aid?
With all this talk of financial aid, it’s easy to assume that it will do most of the heavy lifting when it comes time to paying the college bills. But the reality is you shouldn’t rely too heavily on financial aid. Although aid can certainly help cover your child’s college costs, student loans often make up the largest percentage of the typical aid package, not grants and scholarships.
As a general rule of thumb, plan on student loans covering up to 50 percent of college expenses, grants and scholarships covering up to 15 percent, and work-study jobs covering a variable amount. But remember, parents and students who rely mainly on loans to finance college can end up with a considerable debt burden.
Provided by Ed Wettig, CFP, Wettig Capital Management which offers investment management, financial planning and retirement income strategies. Securities and investment advisory services offered through Royal Alliance Associates, Inc. Member FINRA/SIPC and a Registered Investment Advisor. Wettig Capital Management is independent of Royal Alliance Associates, Inc. and not registered as a broker/dealer or investment advisor.